PPP case study: Anyang

1
PPP case study Anyang Buchon plants, South
Korea

• Raymond Bourdeaux
• The World Bank
• St. Petersburg May 22, 2008

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The Assets a very complex set up
Electricity
Hot Tap Water Heating
Heat
Combined Heat Power Plant
Heat Accumulator
Heat
Heat Exchanger
Heat Only Boiler
Heat Pipe
Consumer Heat Exchanger
Heat
Incinerator
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The Assets (contd)
Huge market potential for privatisation
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Mandate and Rationale

• December 98 Government launches transaction
  advisors search
• Appointed in February 99 by Kepco KDHC to
• undertake 100 sale (assets sales) of
• 2 gas fired power stations (2 450MW) producing
  electricity and heat (combined heat power
  CHP) in 2 different locations, Anyang Buchon
• 2 district heating (DH) networks (about 130 000
  households services each) adjacent to CHPs
• Rationale
• IMF pressure for privatisation and raising cash
• KDHC privatisation plan
• logical fit of CHP DH systems
• teaser for Kepco privatisation
• get rid of difficult assets prior to
  privatisation
• Internal agreed strategy with Client lets do
  it , price is not the top consideration, as this
  will be a difficult sale

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2. The Challenges
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First the good news..

• Not a mammoth transaction early price range
  between 400m and 1bn USD
• Relatively well managed (no need to significantly
  reduce work force)
• Relatively (new) existing assets, no requirement
  for significant extension and/or refurbishment
• Requirement to raise acquisition finance, not
  project finance

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Specific business characteristics of Anyang and
Buchon

• Captive customer basis and long lead time gives
  good visibility for Heat demand projections.
• The obligation to produce heat implies an
  obligation to produce electricity regardless of
  the economic rationale to produce electricity
  (must run status).
• As a result the plants are likely to require
  minimum electricity offtake at certain time
  equivalent to minimum 40-50 plant load factor .

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Strategic Considerations Commercial

• District Heating Issues
• District heating business is regulated
• current price facilitate expansion but is based
  on cheap heat
• local monopoly for existing network, but market
  risk for expansion
• limited ability to push fuel price risk to end
  user
• price regulation to be changed but unclear how

• Electricity Issues
• Kepco is quasi monopoly no market now
• move toward pool market at a later (unknown) date
  means Long Term Power Purchase Agreement not
  acceptable
• Total fuel pass through to Kepco would not be
  fair
• merit order position is not straight forward for
  a must run generator
• liberalisation of Liquefied Natural Gas market is
  unclear

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The Challenges

• Contractual structure
• must run?
• fuel pass through?
• PPA vs pool?

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Strategic considerations objectives?

• Allow operational flexibility and controlling
  must run states
• Managing unions and employee position and
  achieving transfer to private sector at good
  price
• Maximise value and minimise scope for change in
  contracts
• Foreign investment vs. no foreign exchange rate
  protection
• Minimise future KEPCO liabilities and maximise
  value

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Strategic Considerations Process

• 1 or 2 Sales?
• Separate sales of DH and CHP would not maximise
  speed of transaction
• negotiate steam purchase agreement (conflict)
• investors with DH experience have electricity
  experience
• Separate sales of DH CHP in 2 separate
  geographical entities would not maximise value
• 900 MW is acceptable to investors
• 2 sales means 2 parallel bidding processes

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The Challenges (contd)

• Estimate future cash flows?
• Presenting reasonable picture of future operating
  regime
• Price evolution for district heating in a new
  regulatory framework
• Future district heating expansion in a non
  integrated environment
• PPA for set period vs. indefinite obligation to
  supply heat
• Financial modelling refines price between 400 and
  600m USD (allowing foreign exchange protection
  estimated to be worth between 50-70m USD)

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2. Requirement for a successful sale predictable
cash flows
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Strategic Considerations Process (cont)

• Contractual strategy has long term impact on
  players
• existing contract for heat sale between Kepco and
  KDHC sets precedent for transfer price for heat
• the higher the PPA tariff the more KDHC will
  benefit
• LT won market not tested FX protection?
• Acquisition vs. project financing vs. on balance
  sheet

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The challenges issues nobody wanted to talk
about

• How can it be done without Technical or Legal
  advisors?
• Implicit negotiations between KDHC and KEPCO
• Government expectations in relation to impact of
  risk allocation on prices?
• Quality of the Data room?
• Realism of the bid process timetable?
• Flexibility to negotiate key terms if they are
  flagged by investors?
• Overall Government commitment to transaction
  success?
• Transparency of the prequalification and
  short-listing process?

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Solutions

• Short term PPA (1year)
• Automatic renewal until
• establishment of pool market
• Contract for difference
• in future
• Partial fuel pass through structured to provide
  incentives to low electricity production at low
  demand time
• Recognition of must run obligations but
• under operational model

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Solutions (contd)

• Getting the right price
• Maximising investors interest
• Critical mass
• OM savings
• Spare savings
• Market share
• Competitive tender with no deviation criteria
• Allowing free hand on financing
• Feedback between first and second rounds

Gas play Electricity play District heating play
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Commercial Structure District Heating

• 1. Obtain written letter from MOCIE on fuel
  pass through concept on DH price to end
  users
• 2. Obtain assurance of growth possibility by
  securing licenses
• 3. To the extent possible, provide strong
  rationale for growth story (expansion plan)
• limited regulatory protection means that only
  serious DH players will have tools to properly
  value the assets

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Solutions for Fuel Supply Agreement (contd)
Existing FSA with KEPCO

• Medium term rather than matching PPA
• Draft form for investors fine tuning

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Overview of the Deal Timetable What the
Government was prepared to hear
Information memorandum/ financial model sent to
potential investors
Preliminary non binding bids received (6 weeks)
Shortlist of bidders announced
June
September
August
July
October
Phase I
Phase II
Detailed due diligence, meetings and site visits
(6 weeks)
Binding Bids received
Winner announced agreements signed
Closing funds received by KEPCO/ KDHC (3 weeks -
2 months) depending on sale structure
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Marketing the Sale Initial Steps

• 40 investors contacted early on and
  marketed/updated regularly (once a week)
• request for prequalification sent to interested
  parties and published on net
• objectives - select large number of potential
  candidates (either as leader in consortium or as
  potential consortium partner)
• ensure high visibility to further Government
  continuing commitment
• Pre-selection criteria know how (district
  heating, LNG fired power stations, commitment to
  Korea and financial capabilities)
• 23 parties pre-selected

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Marketing the Sale Info Memo

• Info Memo sent to shortlisted parties with
  request for preliminary proposals demonstrating
• key capabilities (financial and technical)
• level of commitment (understanding of business
  plan, treatment of employees due diligence
  requirement, conditions for closing)
• willingness to commit to a price and list of
  subject to

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Marketing the Sale Info Memo

• overview of Korea Economy
• DH and electricity sector description
• description of facilities
• description of main contractual terms
• projections going forward and assumptions
• personnel and organization
• financial model
• In the meantime, preparation of a data room

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Shortlisting Serious Bids

• Out of 23 pre-selected, 12 companies grouped
  forces into 6 consortiums 6 bids
• AES (US)
• Singapore Power (Singapore)
• Dalkia (France) / Sithe (US) Kukdong city gas /
  Kukdong oil (K)
• British Gas (UK) / Daesung Industrial co (K)
• Enron (US) / SK corp (K)
• Tractebel (Belgium) Samchully (K)

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Please wait while we are experiencing some
technical difficulties
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Some problems with the process

• Wide price range in views of uncertainty (price
  with conditions)
• Price is below expectation of Government, but
  fully expectable in view of the short due
  diligence process and uncertainties
• Complaints in relation to the short time table
  for due diligence
• common elements for additional requirements in
  contractual / sale process the contractual risk
  structure was not fully acceptable
• No way the full price will be paid within the
  time frame the Government wants

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Next Step in selection process

• Full due diligence (2-3 weeks) for shortlisted
  parties
• Unconditional bid and fully marked up contractual
  documents (PPA, FSA, Asset Purchase Agreement)
• Preferred bidder selection and final negotiation
• close expected of year-end /beginning 2000

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Actual timetable

• Appointment of financial advisors February 99
• Appointment of technical advisors April 99
• Appointment of legal advisors April 99
• Project launch June 99 (request for
  prequalification)
• Prequalification dues (without forming
  consortium) June 25 99
• Prequalification received July 10 99
• Info memo scheduled to be sent to selected
  parties 25th August 99, sent end September 99
• Indicative bids (non binding) scheduled for Nov
  15 99, delayed until 1 week October 99
• Shortlisting down to 4 to do full due diligence
• Bid submitted 15th December 99

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Actual timetable

• Process collapses ended December 99
• Government announced new Re tendering 12th
  January 00
• RFP documentation sent to bidders on 8 March 00
• Due diligence from bidders March to May 26
• Bid submission and announcement of preferred
  bidder 31st May 00
• Negotiations 1st to 28th June
• Down payment of 10 of purchase price 28th June
  00
• Financial closed September 00

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Relaunch of bidding process

• Revised documentation and more Government support
• Different mix of investors with much more local
  flavor
• Many bidders on first round drop out entirely and
  some new players
• AES (US)
• LG Caltex (LG and Texaco), Texaco (US) and
  Kukdong city Gas (K)
• SK Corp (K) / El Paso (US)
• Daesang (K) / Osaka Gas (Japan)

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And the winner is
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What is less well known

• Most conditions that came as market feedback on
  first round are accepted
• No significant difference in sale price achieved
  in view of the loosening of contractual
  conditions
• Sales is a conditional one with 10 down payment
  while negotiations are ongoing for closure
  scheduled later
• Financing plan based on Korean won with
  decreasing maturities (12 year maximum)
• A large portion of the bonds are placed with
  Korean Development Bank (state owned) who is
  being asked to be helpful by Government

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Everybody was happy in the end..
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GS Power was established in 2000 by acquiring generation and district heating facilities according to privatization policies. Through modernized combined heat and power plants and safe district heating facilities, GS Power sells electric power to KEPCO and supplies heat to 250,000 households in the Anyang and Bucheon areas.

Based on the management techniques and technology of GS Caltex, which has led the Korean energy industry for 38 years, GS Power seeks innovative management and produces and sells quality electric power and heat. GS Power will continue to grow as an energy company with a globally competitive edge.

Located in an urban center, GS Power strives for clean energy and only uses pollution-free fuel. The environment and safety are top priorities in the operating facilities. All the employees at GS Power make an effort to create a pleasant urban environment.

We appreciate your interest and encouragement.
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Life goes on in a privatized company

• February 2008 refinancing of company with a
  1.77bn Won 5 year grace period and 7 year tenor

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Some Lessons Learnt

• Thanks god there was no big competing transaction
  at the same time!
• The timetable cannot be completely imposed by the
  Government
• This is not just about the assets, but very much
  about the contracts around the assets
• Unrealistic expectation to risk allocation lead
  to frustration and (at best) re-tendering
• Investors appetite varies significantly with
  time. They can be frightened away even if the
  market potential is there
• Uncertainty is okay but within a manageable
  framework
• More upfront preparation upfront rarely hurt
• Listening to market under competitive pressure
  makes sense
• If the Government had followed the advisors
  advice, the process would have been shortened by
  one year.

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Outcome

• Large cross section of investors interested
• Innovative financing solutions
• Extensive transfer of risk
• Sale price achieved matching expectation
• Longer than anticipated timetable
• Show that KEPCO/KDHC/NOCCF are willing to execute
  ?? transaction

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PPP case study Anyang Buchon plants, South
Korea

• THANK YOU !!!
• Raymond Bourdeaux
• The World Bank
• Rbourdeaux_at_worldbank.org